Before computers, most sales tax auditing involved the use of block samples to examine transactions. This involved looking at all the transactions within the same “blocks” of time (months, quarters) or accounts.
With the onset of computer-aided sampling, more robust analysis was possible. Statistical sampling, using data in electronic files became much easier to stratify, sort, and otherwise “manipulate” in order to define populations and select samples from those populations. Test results became measurably more accurate, though 80% certainty +/- 20% margin for error might seem odd to call “accurate," and represented a huge step forward. Statistical sampling was a win/win for both the taxpayer and the auditor even if it might come across as black magic to some.
Actual-Basis Sales Tax Audits
As I became more informed about how data is stored in relational databases and the various tools and programs for working with that data, I began to see that an even better audit approach was within our grasp. Even the best-designed test is still just that, a test. Sure, the results can be extrapolated with a measurable degree of confidence, but that extrapolation is almost certainly not THE answer. Additionally, if the liability is based on disallowed claimed exempt sales, taxpayers are not able to fully reimburse themselves from their customers. The liability associated with the customers who were included in the sample is known but the remaining liability simply comes from a mass of customers comprising the population base.
But if an audit is performed on an actual basis where every transaction is “examined” then at the end THE number is known as well as how much each specific customer contributed. I began to approach each assignment with the goal of conducting the audit on an actual basis. The key was extracting data directly from the tables underlying the taxpayer’s system rather than relying on data from report writing software sitting on top of the application. This meant data was coming directly from the “source of truth” with much less chance for corruption. The data output was subjected to some analysis to ensure completeness and accuracy, just as other data sources were checked.
Once the data set was accepted, it was run through different queries (filters) to slice it into different subsets —fully taxed, not taxed, partially taxed, shipped out of state, delivered within the state, etc. Each of these subsets might be aggregated by customer, by product code, by ship to address, etc. for additional analysis —confirm exemption certificate was on file, correct tax rate applied based on point of delivery, etc. Basically data was filtered and aggregated by attributes that could be reviewed and accepted or questioned.
A total actual basis audit was not possible for every taxpayer; some could not provide all the fields of information required for the queries or perhaps the data set was simply too large and too differentiated to be able to query the entire population down to unique reviewable attributes. But even in these cases the initial population could always be queried and made more homogenous before subjecting it to a statistical sample. Since testing a homogenous population generally requires a smaller sample and provides more accurate results, the taxpayer benefited more than if the raw population had been sampled.
My experience has shown that on average actual basis audits can be completed in about the same number of hours as an audit with sampling but the overall elapsed time from start to finish can be less. More time is invested up front with the data extraction and the queries but less time is required following up on questioned items, etc. Taxpayers are also much more likely to accept the audit findings so less time is spent in the appeals process and/or performing re-audits. Overall the actual basis approach is a winning one for both the auditor and the taxpayer; one I suggest every taxpayer consider before agreeing to any type of sampling.
Other recent “Audits and Sales Tax” posts by Lloyd Geggatt:
- Software Audits for Buyers & Sellers – and the 3 Key Questions
- Luxury Audits: Empty Boxes Full of Champagne Wishes & Caviar Dreams
- Sales Tax Audits: Actual Basis Approach Can Result in "Win-Win".
- What Auditors Should Understand About Outsourced Sales Tax Returns
- Auditing Sales Tax Credits: An Auditor's Top 2 Considerations